西斯柯 (SYY) 2006 Q3 法說會逐字稿

Good day, everyone and welcome to today's SYSCO Corporation third quarter physical year 2006 earnings release conference call.

As a reminder, today's call is being recorded At this time for opening remarks and introductions I would like to turn the call over to Mr. John Palizza, Assistant Treasurer. Please go ahead, sir.

Thank you, Joe. Allow me to add my welcome to everyone for joining us today on the third quarter fiscal year call. With me here today are Rick Schneiders, our Chairman, Chief Executive Officer and President, John Stubblefield, Executive Vice President and Chief Financial Officer, Larry Accardi, Executive Vice President Contract Sales and President of Specialty Distribution Companies, Ken Spitler, Executive Vice President and President of North American Foodservice Operations, Larry Pulliam, Executive Vice President Merchandising Services, and Kurt Drummond, Senior Vice President of Finance and Treasurer.

On the call today, I'll give a brief overview of the quarter and John Stubblefield will then provide greater detail on our operating performance during the period. John will be followed by Ken Spitler who will update everyone on our supply chain initiative and redistribution project. Rick Schneiders will conclude our prepared remarks by discussing our strategic initiative. This will be followed by the question-and-answer session which Rick will moderate.

Before we get to the substance of the call, I have one short announcement regarding an upcoming conference where SYSCO management will be speaking. On June 1st, our CEO, Rick Schneiders, will address the Sanford Bernstein Strategic Decision Conference in New York. We hope to see you there.

Now allow me to read you our Safe Harbor language.

Statements made in the course of this presentation that state the Companies' or managements' intentions, hopes, belief, expectations and predictions of the future are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and actual results could differ materially.

Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained in the Company's SEC filings, including but not limited to risk factors contained in the Company's Annual Report on Form 10-k for the fiscal year ended July 2, 2005 and in the Company's press release issued this morning.

To start things off, here's a quick overview of the quarter all compared to the same period a year ago.

Sales were up 9.4% reaching $8.138 billion. Sales from non-comparable acquisitions contributed 1.44% to the quarter's sales from eight different companies: three fresh cut meat companies and five specialty produce companies.

Inflation in our cost of goods ticked up during the quarter rising 2% The cost associated with most product categories increased with the exception of produce, poultry and dairy, which declined resulting in a 2% rise in the cost of goods overall.

For the quarter net earnings were 188.5 million and diluted earnings per share were $0.30 per share.

In a nutshell, this quarter exhibited many of the same traits that we saw in the second quarter of this fiscal year. Sales grew nicely in the quarter, but expenses pressured operating margins.

At this point I will turn things over to John Stubblefield for a more detailed discussion of operations.

Thank you, John, and good morning.

As I look at the quarter, there was some very positive things that come to the fore. To start, sales this quarter continued to build on the sales momentum that started in the beginning of this fiscal year.

Over the past 12 months SYSCO has been even more intensely focusing on sales and the results have been showing up in the numbers. There are really no new developments here, just the continued application of the programs which have been successful for us over the course of this fiscal year.

Business reviews continue to be the most effective tool we have for increasing sales with our customers. During the course of the third quarter we conducted over 10,000 reviews with our U.S. customers and every region continues to see strong results.

We continue to refine this process and the results continue to get better. While we don't track customers that have come in for second and third reviews, the anecdotal reports we get regarding these reviews is that they are as strong as the initial reviews.

We're also finding new applications for the business review process and on a limited basis we're beginning to use the same process in the business development area to bring on new accounts.

We also continue to invest in the human capital required to drive the sales process forward. For the first three quarters of this fiscal year, we had a net addition to the customer contact personnel of 494. This approximately 5% keeping us on the track towards our goal of increasing our customer contact personnel by 6% this fiscal year.

All this contributed to an improvement in our ratio of marketing associates served sales. Our ratio of marketing associates served sales in our U.S. broadline companies increased by 25 basis points from 52.68% in the third quarter of last year to 52.93% in this year's third quarter.

The combination of more marketing associates and customer contact personnel conducting a significant number of business reviews translates into more marketing associate sales.

We don't think our sales momentum shows any sign of slowing down as the first week of the fourth quarter was an all-time record sales week. This is the first time since April, 2004 that we've had a record sales week in any week other than the one preceding Mother's Day.

In the quarter gross margins, gross profit margins were down 2 basis points to 18.87%. The important thing here to note is that our strong sales gain did not come at the expense of gross profit margins.

We did not engage in discounting in order to achieve our sales growth.

Just as they have been throughout this fiscal year, operating expense were our biggest challenge during the quarter. First, fuel costs were a significant contributor to the rise in expenses.

For the quarter fuel costs rose by more than 30% as a percent to sales represented 51 basis points of sales. This compares to 42 basis points to sales during the same period a year ago.

This equates to an extra 10.5 million of expense that we had to absorb in our operations compared to the same quarter of last fiscal year. We are very conscious of the higher delivery costs we face and we are stressing with all of our operating companies the importance of efficient loading and routing of our trucks.

We continue to make progress in this area as the percentage increase n the number of miles we drove in the quarter was considerably less than the percentage increase in sales in the quarter, but it simply wasn't enough to overcome the steep increase in diesel fuel costs from a year ago.

Secondly, we continue to invest in our national supply chain initiative and our expresses net of benefits were 11.2 million in the third quarter of this year. Ken Spitler will speak about our progress on the RDC in a moment, but I want to point out that we are still in the operational ramp-up phase of the project, which means we will continue to incur expense in excess of benefits.

Third, pension expense represented approximately 5.9 million of the additional expense in the quarter.

The fourth factor of note impacting operating expenses this past quarter was share-based compensation expense. For the quarter share-based compensation expense added 26.1 million of additional cost, which was approximately $0.04 per share.

Finally, I would like to note that earnings comparison remained more difficult this quarter due to the fact that last year's third quarter benefited from the reversal of an $11 million accrual for an income contingency which had the effect of boosting earnings per share last year by approximately $0.02.

I'll finish up this section by saying that we are gratified with the continued vitality of sales and the strength we see in the independent restaurant and foodservice sectors. We continue to execute on our game plan and build our sales and market share.

At this point I'd like to turn things over to Ken Spitler, our Executive Vice President and President of North America Foodservice Operations.

Thank you, John.

This morning just as I have over the last few quarters, I want to give you a brief update on our enterprise-wide supply chain initiative we have underway, including the RDC. SYSCO has three major supply chain initiatives actively underway, all of which will work together to position SYSCO ahead of our competition by optimizing our supply chain.

There are a planned network of seven to nine RDCs. Two, the reorganization of the transportation management function into a national and regional structure, along with the implementation of the new transportation planning and execution system, and the national implementation of new demand planning and inventory management software.

These three major steps are designed to provide SYSCO with an integrated supply chain system and an end-to-end optimization.

Now for an update on the RDC and the status of our other initiatives. As you are aware, we placed a hold on new supplier volume coming to the RDC back in November 2005 un order to address what we considered a normal start-up operating system adjustments.

The results of these changes have been impressive and our key metrics are showing improvements. Some of those are RDC, direct labor cost per case has improved more than 40% from December to this March.

RDC cases per man-hour have improved more than 30% during the same period.

RDC outbound truck fill, the measure of how effectively we use our outbound capacity, is exceeding our business case. The Northeast operating companies cases per man-hour, have improved 7% since December.

Total inventory in the Northeast region, including inventory in the RDC is essentially equal to the inventory levels in the Northeast region in 2004 prior to the RDC becoming operation as measured in March, even though we are now supporting a higher level of sales in the region.

We continue to make improvements over the next coming months, a few example of those are the implementation of cross docking, the implementation of efficient case picking, the continued refinement of efficient shipping multiples, and further optimization of the debt of our dedicated fleet that services the operating companies from the RDC.

The improvements allowed us to renew the ramp-up of case volume for existing RDC suppliers in February. We're on track to begin adding new supplier volume in June.

In December we averaged 711,000 outbound cases per week compared to March average of 720. During the first few weeks of April we averaged 780,000 cases per week and our current plan calls for continued increases in the controlled and measure pace.

The majority of our target case volumes should be achieved by the end of calendar 2006.

As we previously announced, in January we purchased the land for a second RDC in Alachua, Florida. We are now engaged in the design process to tailor its operations to service the five operating companies in Florida.

We anticipate that construction should take approximately 14 months from the time we break ground. We have also announced Hamlet, Indiana as a site of our Midwest RDC to service operating companies ranging from Ohio to Wisconsin.

Good progress is also being made on our national transportation management initiative. 28 of 69 broadline companies have been converted to our new transportation and planning system that provides the capability to view and manage all of SYSCO's inbound freight both to RDCs and to the operating companies.

This means that SYSCO will manage its inbound freight as a network and not as individual locations. 41 operating companies are scheduled to be fully converted by the end of the fiscal year and the remaining companies being converted during the first half of fiscal 2007.

All the personnel previously dedicated to managing individual operating company freight, [inaudible] freight needs have been transitioned into their new rolls that will focus on optimizing our network. This will be a significant advantage for SYSCO in times of rising fuel costs.

We are also on tract to have our new demand planning and inventory management system, that enables the kind of inventory results previously mentioned, implemented across the broadline companies in the first half of fiscal 2008.

And now I'd like to turn things over to Rick Schneiders.

Thanks, Ken.

I'm going to take some time now and talk about issues that go beyond just the results for the most recent quarter. During the past year SYSCO's executive team and the board have been engaged in a strategic evaluation of the businesses and processes here at SYSCO.

Over the 36 years of our existence, we've been a company that's grown and evolved to meet the demands of the foodservice industry. Today SYSCO's a company with more than $30 billion of annual revenues with customers ranging from the small independent restaurants to some of the largest foodservice providers in the world.

We can service just about any need a provider of food away from home requires to run their business. We sell commodity items and specialty items, large quantities and small quantities.

In short, we've become a very large and complex organization. That is why we were undertaking a deliberate, disciplined, strategic study of our business and what we need to do to help ensure that the growth over the next 36 years matches the growth of the last 36 years.

We've established a strategy team which is examining every aspect of our business with an eye towards identifying where we are strong as well as where we can make improvements. We've set our sites on becoming the best in the world at moving multi-temperature food products from any point on the globe to any other point on the globe.

In order to achieve this we intent to be able to offer our customers the best combination of ease of doing business and cost. This process will entail driving further distribution expense out of the system and procuring product more efficiently while simultaneously becoming more aligned with the needs of our customers.

When we put these elements together in the right combination for our customers, our potential for growth is almost unlimited. This is a multi-year process which we intend to make part of the SYSCO culture.

We will update you as we further refine what we see as the drivers of our future growth, but for now, I want everyone to know that we continue to see the North American market and the way we address the needs of our customers here as the number one driver of our future growth. We see tremendous opportunities to continue to grow our market share in North America into the foreseeable future as we reassess old assumptions about how we do business.

International markets will overtime play an increasing roll in our business. We already source product globally and we do a small amount of international distribution through our subsidiary, International Food Group.

But the size and scope of the North American market, coupled with our low market share, means that most of our growth for the time being will be right in our backyard. We're relatively early on, but we are quite excited by what we see.

As we move through this project, we believe that we can identify ways that we can buy better, distribute to our customers more efficiently and adopt world-class technology and practices faster. In short, we intend to built on the existing strength of our operating companies and integrate them with world-class operating practices.

Thank you. And, Operator, we'd now like to take questions.

[OPERATOR INSTRUCTIONS] One moment as we assemble our roster. And our first question today comes from Andrew Wolf with BB&T Capital Markets.

Good morning.

Good morning, Andy.

Versus what I was thinking for, I think everything was pretty much in line except gross margin where I was looking for a little more expansion than what you got. Where you didn't get any. So I was glad to hear John say you're not going out there discounting and I wasn't too surprised to hear that but could you give us a little more granularity on the gross margin? Some of the puts and takes?

I mean the street mix was up, which would be positive. The private-- SYSCO brand was down, that type of thing.

Also, food, or your product cost inflation was higher than I anticipated. I'll give you a second to answer in a second. Going up sequentially. Was that because some of the non-food items like resin and oil-based products were going up faster than you could pass them through or was there just something in food that I didn't anticipate was actually inflating more than I expected?

The biggest, as you've already indicated, the biggest impact to inflation was in the non-foods areas, the paper and disposable areas. And you're exactly right, the increases in resins for all packaging-type items is increasing pretty significantly.

We were actually pretty pleased, we have a 2 basis point change in the gross margins, but based on the environment, based on the change in the product mix we thought that the margins held up well, but I think the inflation/deflation, the movement of the product had a big impact on our margins today.

John, did you want to add anything to that?

No, I think that's accurate. A number of the categories were up that do have longer term pricing with a good number of our customers, which does impact us in the short-term. I think we'll see that, you know, level out as we go forward.

We're in, just to add one more thing. We're in now what we would characterize as more normal inflation/deflation. That 2 to 2.5%, that's historically been the number that we've dealt with over the years over the longer term.

Do you think the market's, SYSCO and the rest of the market will pass through petroleum-based inflation with the normal lag?

Oh, absolutely. Depending on the speed of, or the rate of increase, the rate of the inflation itself, it takes a little longer sometimes, but 2 to 2.5% is a very manageable range for us to get virtually all of those increases back.

Thank you.

Thank you. We now will hear from Mark Husson from HSBC.

Yes, good morning.

I think we're probably understandably obsessed with the cost of gasoline right now and I wonder, maybe Ken, you could just talk to us about the RDC and specifically, will the RDC reduce the number of gas miles, if you like, for the Northeast in the near future, if you just isolated that one thing out of the whole sort of change in the way you do business? And how many those gas miles would have been your miles rather than your vendor's miles?

Just, you know, we haven't measured that, Mark, but on the inbound that would only improve on the inbound side where there's a lot of activity on the, where we spend our most money is on the inbound, excuse me, on the outbound side from our operating companies. We have a lot of initiatives going on there on the ROUTH side and of course one of the things we're looking at is just trying to reduce those stem miles and that's our big initiative that we're studying right now is how do we reduce stem miles.

As far as the RDC is a clear big one straight off and what you have to do is re-engineer the stem miles on the other side to make sure there isn't a penalty in terms of the extra distribution.

Right.

Okay.

I think more broadly, Mark that the RDC, just from looking at the total system and the reduction in miles because of the trucks flowing to the RDC and to the operating companies, there will be more efficiency and we will get more pieces per mile, which is a good measure for us so the RDC will definitely enhance that piece of our efficiency.

And then just switching gears a little bit following up on Andy's question, I guess I'm still a bit foggy about the gross margin mix. I mean we don't hear much about some of the different bits of business like guess supply and produce and meat and so on. Obviously a lot of acquisitions in the produce area. Would that have a meaningful effect on SG&A and gross margin?

No, I mean it will have an impact on it. Produce is one of those categories of product where we have more variability throughout the year because of, you know, short-term weather can impact produce pretty dramatically and pretty quickly, so when we had heavy rains in California here in the last couple of months, that will drive the price of produce up pretty quickly. On the other hand, the produce prices moderate pretty quickly also.

So you know, again, I think that the margin's remaining essentially flat in a time where we've got, you know, some movement, some kind of inflation up on produce, meat prices did go up some during the quarter, but not like they were inflating a year or year and a half ago. So I think that the operating companies did a good job of managing gross margins frankly.

One final very big question on California.

A couple of restaurant companies have mentioned it was bit soft. You don't seem to be seeing sales softness anywhere, but it is softer than you thought, California?

Actually we, Ken, I'll ask you to help me here, but if you look at the regions we have a West region that California is part of, a big part of the West region, and in fact, the West region is performing quite well at this point.

The regions generally, all five, and if you include Canada, the sixth, the regions are growing nicely, although I would say that the upper Midwest due a lot to the automobile-- what's happening in the automobile industry, is a little less vibrant but we're seeing year-over-year growth throughout all of the regions in California and the West Coast doing, you know, doing certainly their part.

Great. Thank you very much.

And actually, California is quite strong for us.

Yeah.

Our next question comes from Steve Chick from JPMorgan.

Hi, thanks.

Rick, in the press release you had some encouraging comments about the cost pressures. You know, you said that they'd continue into the fourth quarter, but that hopefully they'd lessen if not disappear going into next year. And by my math, I've come up with, of the costs you've been outlining for us by the end of this year, I think it will be somewhere in the area of $0.26 a share, you know, stock options and [already seen] and so forth. Can you give us a little bit more specifics on what that number could look like going into FY '07?

I think your math is, I'm not going to double check your math I think it's pretty close, Steve. If you take out the stock option, the stock options year-over-year are going to be roughly the same '06 to '07. And in fact we may see over-- a little longer period of time we'll see the stock option expense decline somewhat.

The other four or five categories, pension, fuel cost, RDC, et cetera, they begin to get, you know, essentially flat year-over-year. So, you know, I guess I'm just confirming what you asked that those are the numbers you are close to what we're looking at.

Right. Okay.

But when you say flat, I mean, well starting off, I guess, before with the stock option [expense] you come in at $0.17 a share at the high end and I don't know if John has this handy as well, but isn't there a good chance that that will be lower next year because of something to do with the tax [inaudible] options and so forth?

This is John.

You're correct. If some of those become non-qualified then we could pick up some tax benefit. A good point on that is that while we had 26 million of pre-tax expense, we only had 4 million roughly benefit off of that. I'm sorry 2 million benefit off of that for taxes this quarter so we looked for the longer term to pick up some tax benefits going forward.

Steve, to your point, if you look at those three items, fuel, pension and share-based compensation, fuel being roughly a penny, pension being roughly a half a penny, and share-based compensation $0.04 that's $.055 in the quarter that we really think are out of ordinary, let me characterize it that way to the quarter last year, and then you take the cent and three-quarter or $0.02 off of last year's quarter number as the reversal of that tax accrual, we're really looking at roughly a 10% EPS increase this quarter normalized for those three items. And as Rick said, we believe that given fuel costs don't increase much over where they are today, then the worst case then in that situation would be flat so we would leverage over our current fuel costs.

Pension runoff of the discount rate, principally, we see discount rates creeping up a bit which will be a positive to next year's calculation and share-based compensation, at this point, at best kept can say is going to be flat next year, could be some small improvement.

So I guess to size it up, it sounds like, you know, we're talking worst case here if I come up with $0.26 a share, I guess worst case it's going to be the same, you know, next year. It sounds like more realistically that we're going to see a lower hit to your P&L, I guess, it's just difficult to quantify at this point. Am I taking that away appropriately?

No, I think that's accurate and, you know, we anticipate leverage coming back to the bottom line this next year.

Okay.

So if you look at the underlying operations of the Company, and you see the progress that John alluded to there by taking out a couple of extraordinary items, we see that kind of performance improvement, the operating companies and assuming that we continue to see relative sales growth in the range that we've seen it for the last quarter, you know, we're going, to use John's words again, we're going to leverage at the bottom line in '07, so frankly, we're very encouraged about that.

At the same time I will assure you we're not giving up on the fourth quarter of '06. We continue to work hard on controlling fuel expenses, routing our trucks better, running our operations better and, you know, some of the good hard work that's happening at the operating companies is not reflected in the numbers, but I assure you that there's a lot of it going on and the operating companies have been doing their part. So we're working hard on fourth quarter and we look forward to '07 also.

Okay. And two more questions, but one related to that.

On the RDC line, it does look like it's going in the right direction sequentially and, frankly, it's still a little discouraging that you've been talking about it for quite a while and it's still an overhang on the P&L but can you speak to that as number two comes on, you know, broadly, I mean is this, you know, can we expect this to break even in FY '07, which would be nice to see? Do you guys think you'll be in a position to say that?

Steve, we're not giving that specifically guidance, but clearly, our experience with the first one gives us confidence as we rollout the second one, we'll do it quicker, more effectively than what we did the first one and we'll see the benefits come faster on the second one than we did the first one.

Yeah, and I would add to that that one of the reasons, one of the big reasons that we sort of put things on hold for a while going back to November and in to March was, we wanted to make sure that as we opened the second and the third that we had the adjustments, to use Ken Spitler's term, that we had the adjustments made in the systems, that we had done the tweaking so that the rollouts will be obviously much smoother going forward.

We will have already done the work we need do with our vendors in terms of the on-boarding process. A significant number of the vendors from the Northeast will be in the Southeast and into Indiana, so a lot of that work has been done, so it just makes it easier and more efficient going forward.

And number two starts hitting the P&L in-- when is that again? It's 14-months from when you break ground. You haven't broken ground yet, right?

Not yet. We're thinking that that should start to break ground in late July.

So this will spill an, yes, it will spill into FY '08 in terms of when we see it in the P&L it sounds like.

That's right.

Keep in mind, too, the reason I mentioned the transportation planning we did those simultaneously when we opened up Northeast, so we had to do those at the same time or just a little prior it to. This-- the second and third ones we're well ahead of that with instituting those two initiatives.

Great. And then last question for Rick, I guess.

Rick, I've taken a look at your stock price performance and it's underperform in the market the last two years, and it's kind of started off year-to-date a little sluggish and the last time we saw this was kind of when you were right knee deep in the [soft] system investment and, of course, after you cycled out of that it came back with a vengeance, so I'm kind of wondering if you can relate the period you're in now to back then first?

And then second, what kind of discussion, I mean what does the board think these days and what kind of discussions and maybe pressures are you getting on that end?

Well, I'll answer the second question first and that is that we have great support from our board at all levels on the strategy and the longer term strategy and on the execution of the business itself. They, of course, see the numbers that we've talked about today, the underlying, the kind of operating margins of the Company, and so I, no one that I know of is pleased with the price of the stock, but we don't control that.

We continue to run this business for the benefit of our customers and our shareholders so we're in this for the long haul. It's the only business that we know.

And second to the first question in regard to the parallels between what we see right now and going back to '97, '98, '99 and installation of [SUS], I think it's a great analogy and that was the right thing to do for SYSCO at the time and the big investment, RDC is the right thing for SYSCO and the industry, for our customers it's a big investment. They all take longer than you would hope. They sometimes cost more.

Fortunately, based on our projections are, the costs that we anticipated are coming in right in line with those anticipations so, yeah, it's a great parallel and, you know, we're very pleased with the progress of the RDC and the benefits that we're beginning to see even at this roughly 50% ramp. We're seeing significant benefits some of which Ken shared with you earlier. So yeah, I think it's a great point.

Okay. Thanks, guys.

Thank you, Steve.

John Heinbockel with Goldman Sachs has our next call-- or question.

Hey, Rick.

I know the sales trends have been good. How concerned are about where we go with $3 per gallon gas particularly since a lot of the casual dining restaurants are struggling with badly with traffic right now? Is that a concern or do you think you'll blow through by taking share during this period?

I'm confident that based on our initiatives and the results that we've seen now over the last, roughly, four or five quarters in terms of our sales uplift, that we're going to continue to see the kind of-- I can't promise we'll see the same kind of growth, but we're going to see a relative kind of growth that we've been seeing and that we are going to continue to take share out there in this environment.

And to the first part of you question in regard to the $3 gas at the pump, you know, sure obviously it is a concern to us. However, reading on the front page of the New York Times this morning, you see that consumer driving and consumer spending has not been influenced that much. Folks are still driving.

Folks are still eating out, and it's another sort of a, you know, kind of an underlying benefit of owning SYSCO stock, I guess, is that our business is diversified in terms of the types of customers, so we've got good chain customers, great folks out there, but we've got those independents, also, who are able to change their business, change their menus more quickly, and we see good levels of activity in that independent sector right now. So again, and of course we've got other kinds of customers out there hotel, motel, nursing home, healthcare, schools and colleges that tend to be pretty level no matter what's going on in the economic environment out there.

So yeah, all of that to say, sure we're concerned about $3 fuel. We'd love to see that reversed, we'd like to see action taken. At the same time that's something that when I say action taken more broadly, but we're taking action in terms of our underlying costs making sure that we're managing those fleets appropriately. But we are watching our customers and how that $3 fuel is impacting their business.

Wal-Mart announced a same store increase [inaudible] but 6.8% increase, so there's-- and the overall economy performed well in the third quarter-- our third quarter, and so we just keep doing what we think are the fundamentals in our business and it will pay dividends at the bottom line.

What do you think will be the biggest gross margin variable next year and will we ever going to get to a point again where SYSCO brand as a percent of at least MA sales are increasing where we kind of topped out there?

Hard to say. I don't think we will see significant increases in how the percentage of SYSCO brand as a percentage of marketing associates serve the business.

However, as we've shared with the public, with the market before, we think that our strategies in terms of reviewing the specific products that we have in this SYSCO brand portfolio, we think it's the right strategy, we think it's the right direction and, ultimately, as we are able to transition through some of that we get our sourcing programs completely in place, which, we're in the process of making some changes there that there's gross margin opportunities in the future for SYSCO brand and for non-SYSCO brand filings.

Do you think that longer term that the trend should be up in gross as opposed to flat?

Yeah I'd like to, but, again, let's, I want to make sure we're not focusing too much of that gross margin line where for three, four, five years a lot of the net margin improvement came at the gross margin line and our anticipation is that most of the net margin improvement will have to come on the cost side of the business. So our focus is on cost, our focus is on continuing to improve SYSCO brand, the quality in those products, making them available to our customers, making sure they've got the right value in them.

On the other hand, a great deal of our focus now and in the future and most of the growth at the net margin line will have to come on the expense side of the business.

All right.

And then finally, maybe touch on use of free cash as we go forward with debt to capital 40% plus and interest rates going up, is there more likely to be debt pay down and less share buyback going or you'll continue what you've been doing?

I'm going to ask John to elaborate on that but going forward, we were aggressive in the first half of the year. We are going to pay down more debt perhaps have less share buyback going into the future.

However, you know, we have always bought back the allotment that the board has given us and we'll be going back to the board, I'm sure in the near future for another allocation and we will, I'm sure execute on that also.

John do you want to add anything?

Rick, there's a lot to add to that but we did moderate somewhat in the third quarter in our share repurchases, we'll see that further moderation in the fourth quarter, and again, we expect to be well within our stated goal range of debt to cap and that is the 35 to 40%. So we expect to be in that range come the end of the year.

Just to the point of cash, I will make a couple of comments about the balance sheet and that is, we saw a good performance in the quarter both in receivables and inventory, and remembering that we measure days outstanding in both of those categories based on trailing five weeks of sales history because of the shortness of both of our receivables inventory, and we saw in the case of receivables that the days were basically the same this quarter versus a quarter a year ago at 22.48, 22 days and a half roughly. And if you look at inventory, our inventory days actually improved this year over last year, 17.02 to 17.36 last year.

The one area in cash flows that did impact us in the quarter was in accounts payable and we did have fewer days outstanding in accounts payable this year versus last year, 19.5 roughly this year versus 20.6 days last year. So part of the RDC project, because we've gone to more electronic remittance to a number of supplier has impacted those days, that we're working hard to get those days back at to what have been more historical accounts payable days which will, again, be very positive to the balance sheet on cash flows.

Okay. Thanks.

And now we will hear from Meredith Adler from Lehman Brothers.

Hi, guys. A couple of questions.

When Steve Chick was asking his questions about the impact of the second RDC, obviously you capitalized the costs. Are there any costs associated with that RDC that will in fact flow through the P&L next year?

Well this is John.

And there will be those start-up costs of the new operation are expensed as opposed to capitalized. However, again, we anticipate, and not to hold a specific time period, but they'll be, three to six months worth of ramp-up operational costs as opposed to 12 to 18 months as we saw for the first RDC. So the ramp-up time will be shorter on the second one than it was the first one and those costs are expensed, however, we don't believe they'll be at the same level that the first one was.

That's right.

And those will fall into '07 or into '08?

Actually, they'll fall into very late '07, possibly clearly most into '08.

There are some training costs included on in what John was speaking about on the DPR in the transportation system that we'll be doing next year.

And actually we'll even have of those into this year but they're not significant.

And then another question I have about a pension costs. Where do you see those costs going in the next 12 to 18 months?

Well, my crystal ball says that discount rates will continue to rise. Our measurement date is at the end of May, and given that we think we'll see the discount rate rise slightly from this last year's calculation, which will give us a small reduction, potentially in the pension expense.

Beyond that we think that the investment performance will be positive this year, and that the overall liability won't change significantly so that we would anticipate, again, pension being flat to maybe slightly down next year, but for all practical purposes, probably flat. We'll give guidance on that at the end of the fourth quarter.

Okay.

And then we noticed that there was a further deceleration in revenues at Sygma. Can you talk a little bit about that business?

Well I'll ask Larry to comment on that, but the fact is that Sygma, of course, their customers are generally quite large, and so we get that business in fairly large chunks. So just depending on timing, their rate of growth can increase or decrease-- move a little bit.

So Larry, do you want to say anything more specifically about that?

Well, yeah, that's exactly correct. We acquire contracts throughout the customer life cycle, and we'll start to [wrap] with some of those contracts that we secured 12 months ago. And we also, because of our limited space in the distribution centers, we're very selective with when we can take that business on.

In many cases we have to do some expansion, and so there's a timing factor there as to when we can increase our business, and when we do, it comes in large chunks.

So no concerns?

No, not any concerns. We're very active. We have several customers that are basically now just waiting for us to complete our expansion project so we can talk to them about some contracts in the future.

Meredith, I'd say more generally that the activity around associated with Sygma, has been quite robust. It's more of a timing issue but there's a lot of activity with Sygma right now.

Great.

My final question is back to, I think, the first discussion about inflation, and I'm not sure I was understanding what was being said. I know you're saying that 2% is way closer to normal than what you may have seen in the last couple of years, but are you actually having an impact on the gross margin either because you're seeing deflation in some categories or because you're seeing inflation that you're having trouble passing along? I was unclear.

Yes, I mean I think that what's happened-- let me say that the changes in deflation/inflation, the more significant changes goes back to 9/11, after which we had significant deflation. My memory is about 3% deflation. Then after a period of going back to 18 to 24-months ago, we had significant inflation at one point reaching for all categories just over 8%.

So in the period of a couple of years, we had a swing of 11% from a negative 3 to 8%. And as we talked throughout those times about the challenges with managing the business and managing the gross margins, we are now in a more, obviously, a more stable environment.

Inflation has gone from roughly .6% to now, point, added points, 2 percentage points, and so it is easier to manage in this environment. And I guess if the underlying question is, what's the impact of the current inflation to the gross margins I would say that it's, you know, there's some impact based on the movement within the categories, but it's certainly less impact and-- the change of 2 basis points this time. It's certainly less impact to the gross margin line than what we've seen in the last two or three or more years.

Okay. Great. That was very helpful. Thank you.

Sure.

We have another question from Jason Whitmer with FTN Midwest Research.

Thanks, good morning.

Rick, I want to go back to market share which apparently seems to be flowing nicely given a little bit slower industry fundamentals, but could you break down maybe within your share gains, if you can describe the mix between penetrating more within your existing customers, primarily you primary customers and then maybe moving some secondary customers of primary and then finally picking up new customers. Can you describe that dynamic for us?

Most of the growth on the independent side of our business, on the marketing associate's serve side of our business, is coming from penetration of existing customers. And John alluded to our business review process this morning, which continues to produce really exceptional results, mid-teen growth continues to produce mid-teen growth for those customers going through review.

Nine to 10,000 customers have gone through reviews, went through reviews during the third quarter. So it's producing a significant amount of the lift on the marketing associate's serve side of our business, which is, I don't remember the exact number, 56, 57% of our business.

So in the broadline sector.

So, yeah, and then I would also add to that we are selectively adding new, good, independent customers to the SYSCO family. And the business development process, which is kind of the mirror to the business review process, which is dedicated primarily to getting new, good customers, is a little less mature than business review, but we're really seeing it gain legs here and producing some nice results, so, but specifically to your question, most of the growth is coming from existing customers.

And my own other question, if you could provide a little more color and granularity in terms of the your strategic process right now. Is sounds like you're still, [inaudible] rating although you've been at it for a little while, can you address whether that's systematic within your, you know, operational structure at the op-co's or something at corporate where it has deal with pricing or labor initiatives or is that just kind of an overall end market assessment of kind of where you are at and where you'd like to go?

Right now where we are, we're in roughly the first year, toward the end of the first year, much of what we've done so far at been at the senior executive level, much of it's been preparatory just getting some processes in place.

Ultimately where we want to be a couple of years from now is that to the strategic process itself has to be embedded within the operations of the Company. So it isn't like we're going to have a massive strategic planning department, that is not the intent.

We want to have, we want to continue to have the good ideas bubble up within the operating companies at Sygma, the specialty companies. We want the good ideas to bubble up from there and just make sure that we're better at getting those new innovations installed in the total operation of the Company. We just need be faster at that.

We have talked with the investment community before about things like activity-based pay, which produces pretty significant results in terms of the productivity of our drivers. Well, some of those things just have taken too long for us to get across SYSCO.

So what we want to do is, again, simply is we want to have, the strategy needs to be a process by which we take the good ideas that come from the operating companies, come from the specialty companies and then we install them more quickly throughout the organization, gaining bigger benefits more rapidly than we have in the past. I hope that helps.

Sure. Sure. Thank you.

Our next question comes from Thomas Crowley with Putnam Investments.

Hi. Good morning, gentlemen.

Good morning.

I just had one quick question.

I've been on and off so I don't know if this has been asked, but can we just talk about the cash flow statement and the cash from operations seem to have gone down by roughly 200 million, and it's basically the decrease in accrued income taxes and inventories and some working capital. Is that just a timing thing that should reverse in the fourth quarter?

This is John again, and let me first talk about the third quarter, and if you look at cash from operations for the third quarter, the impact is really in two items, and that is looking at third quarter this year versus third quarter last year, and that is, first coming from our tax payments that we made, as you said, there's about a $40 million difference this year versus last year, more tax payments this year than last year by 40 million. In addition, the increase in accounts payable, that I alluded to previously, there's about a $70 million swing in cash flow from accounts payable this year to last year that makes up roughly 110 million of the 130 million swing in cash flow this year versus last year.

And then if you look at the 39-weeks information, what you see is that the increase in receivables and increase in inventories is roughly equivalent to our sales growth in those two categories, and if you take those two alone, that's roughly $150 million for the year in terms of increases in those two categories.

So again, if you look at our absolute days investment in those two categories at the end of March we're very much in line. If you look at the increases in those categories n dollars, it's related to what we see as pretty strong top line sales growth for that same period.

So I think those are the two key factors. Also on the 39-weeks, as you look at the accounts payable, there's not much difference in terms of the accounts impact on payable cash flow for the 39-weeks.

Again, the fourth quarter is always a strong quarter us in terms of cash flow. Schools are out, those receivables are collected in by the close of the year, so we're looking for as always a strong cash flow fourth quarter.

Okay.

And then just lastly on the deferred tax provision. Over the last few years that used to be a lot greater than what you are actually paying out?

That's right.

As thinks go in reverse is that what we should expect going forward? Should they be about even or-- still be lower?

No, what we will expect going forward is that that deferred tax position will stay relatively the same except for incremental growth in our business. The deferral that was built up over roughly an 18-month time period is now being paid because it is a deferral, however, new deferrals continue to flow into that based upon the growth of our business. So we would expect it to grow incrementally going forward.

Okay. But we're now at steady run rate where there's no mismatch?

That's accurate.

Okay. Thank you.

And our next question comes from Ajay Jain with UBS.

Yes. I had a question just regarding some of the recent developments at Wendy's with the spin ouch of Tim Horton's and the management changes at Wendy's and in the composition of their board are you seeing any impact in terms of their purchasing activity and are there any other implications you can comment on for SYSCO and for your Sygma business longer term?

Well I'll start and then Larry can certainly add to that, but our relationship with Wendy's continues to be very strong. We have a good relationship with Tim Horton's in Canada and in the U.S. and we anticipate that as their business grows our business will continue to grow and, in fact, the new, the CEO that's in place right now, is one that we have a relationship with. We've had relationship with Kerrii for a while either directly or indirectly.

So she understands the Sygma/Wendy's relationship well and we don't anticipate any significant changes. We're very big supplier to them. They're a great customer to us. In fact, we've picked up a bit of additional business here recently and so we will continue to serve Wendy's and be proud distributors to their operations.

Larry, did you want to add anything to that?

Well, just again, the relationship is very strong and most recently we have been working with Wendy's addressing some of their operational issues and both of us to attempt to become more efficient.

Thank you.

I just wanted to shift gears to the higher fuel costs for a second. I seem to recall there were plans in place last year to be more hedged on gas through fixed-priced contracts and I was wondering if you can comment on how effective you've been the area of risk management as far as fuel is concerned.

Also, more generally, why you've had to absorb the higher gas prices this year. It seems that you're either reluctant or unable to use surcharges to offset the higher fuel cost with your street account customers, and I'm just wondering if you can speak to that at all.

With our street account customers we do not have, generally, we don't have fuel surcharges. That's accurate, and we have to respond with pricing for those customers. For chain customers both at Sygma and broadline companies, we do have fuel surcharges in place and we don't recoup 100% of the increases but we do have fuel surcharges in place.

John, if you would speak to our hedging process, if you will, and where we stand there.

Well this is Ken.

Rick, we're hedged right now in through July at a pretty good-- at a fair rate, and beyond that, we keep looking for a place in the market to go out again, but as you can imagine, that's pretty difficult game right now.

Yeah, I think the bottom line there is that we not been to some degree hedged this last fiscal year our fuel cost would have been significantly higher than what they will right now. So net-net we're ahead of where we would have been had we not been hedged at all, it's just that the fuel costs are run up so high so fast that it's been most difficult to stay ahead of them.

We recently had some meetings with our fuel supplier and looking for a place to go back out again, but again, it's a little bit different today than it has been in the past. There's a lot of things in play in the market and there's a lot of risk built into the market right now that tell us not to rehedge until some of that risk comes out.

Okay. Thank you.

And I also wanted to get some clarification, Ken, on the 11 million in RDC cost for the quarter. I know you mentioned that that's net of benefits, but I seem to recall you expensed 14 million last year in Q3 so I just want to confirm how much of the RDC expenses is incremental compared to last year because on the surface it looks like the cost comparison should have improved if your net expense was 11 million.

Ajay, the thing you have to keep in mind now is that the RDC is in a totally different operating environment third quarter this year from where it was third quarter last year. They are fully staffed, they're running a big business today, so your costs-- your actual costs are significantly higher than what they were a year ago.

What you have now coming in is the benefits to offset those costs, so the direct benefits, measurable benefits to offset those costs, which net have us down below what we reported last year as just operational startup costs very early on in that third quarter.

So it's really an apples and oranges comparison, and that's why as quickly as possible we need to get out of talking about what are the expenses of the RDC this period versus a period a year ago or two years ago, because that businesses has evolved, it's changed, it will continue to change as we get it fully ramped up.

Great. And my last question, I promise, is on interest expense.

I think, John, you mentioned on a previous call that debt to capital would be in a more normalized range for the rest of fiscal '06, and I think you reiterated that earlier on this call, but now that you're ramping up for more RDCs what's your outlook in terms of borrowing needs I guess going into next year?

Just to restate what I said earlier, we believe that debt number will come down in the fourth quarter. If you look at the additional interest expense that we had for third quarter, 20% of it was due to rate, the 80% was due to volume and we think that volume will come down this fourth quarter, and we certainly have plenty of capacity to go forward in terms of debt, and we will continue to manage in that 35 to 40% range going forward.

And the RDCs going forward now will-- the capital avoidance in that particular geography that an RDC will serve will be greater than what we will spend in terms of the capital for the RDC itself. So in the Northeast we have already seen reductions in the requirements for capital for expanding our facilities.

We're even seeing some of it in the Southeastern U.S. in Florida specifically in anticipation of the second RDC. So we're putting off projects in Florida that we would have normally have done because they know that the benefits of the second RDC are going to accrue to them and they're not going to need the space that they might have once needed.

Okay. Great. So the debt to capital shouldn't be materially higher than 40%?

No, sir.

Okay. Thank you. That concludes the question-and-answer session today. At this time, Mr. Palizza, I would like to turn the conference back over to you for any additional or closing remarks.

Thank you, everyone, for joining us on the call. If there are further questions, as I anticipate there probably will be, I can be reached at 281-584-1308. Look forward to talking to everyone.

And that concludes today's conference. We thank you for attending.